The goal with any investing should be to structure it in a way which maximises deductions while minimising non deductible debt.

When building a duplex or 2 properties the aim to live in one and rent out the other ideally you would want to borrow for the investment portion and use cash for the owner occupied portion. This won’t be possible where you have one building contract and one land title as it is a big pool of costs. The result will usually be one big loan and a mixed purpose with apportioning of interest necessary.

This is less than ideal as you will waste money in extra tax by paying down investment debt. If this happens to you the best way forward would be to split the loan at completion into 2 portions. The investment portion and the owner occupied portion. To do this you will need a valuer to work out the value of the land and building for each portion. You would then split the loan accordingly.

An even better way to structure this would be to borrow the lot from the beginning. Even if you have half the project’s value in cash you should still borrow the lot. Then once the project is completed you can split the loans. The balance of each portion will be high. This doesn’t matter because you have a large sum of cash which you can then use to pay down or offset the owner occupied loan.

This will maximise deductions and minimise non deductible debt. I’ve just saved you thousands of $$$$.

It may be possible to separate the loans and then subsequently set up offset on the non deductible portion. I suggest a private ruling.

See also IT 2661
Quote:

12. In certain cases, such as Carberry, a single asset (such as land with a single title) may be capable of being properly regarded as having been notionally divided between a part acquired with a business purpose and a part acquired with a non-business purpose. In such a case, borrowings may be properly regarded as relating to the notional part of the asset acquired for a business purpose and a deduction will be allowed for the full amount of interest paid in respect of the borrowings.

13. However, for this method of apportionment to apply, it must be shown that the borrowings in fact relate solely to the notional part of the asset acquired for business purposes. In Carberry, for instance, the taxpayers were able to show that the part of the asset purchased for private purposes was paid for with the monies which the taxpayers had received from the sale of their previous residence. Accordingly, it was open to the Tribunal to find that part of the asset purchased for business purposes was in fact purchased with the borrowed funds.

Tom owns 123 Smith st. land is worth $500,000 and it has an existing house on it which will be knocked down. $500,000 is needed to build a duplex. Existing loan is $100,000. Tom has $250,000 cash and wants to borrow $250,000. He thinks he can pay cash for the owner occupied portion and borrow for the investment portion.

He gets a valuer out and each portion is roughly 50%. So 50% of the land will be used for the owner occ and 50% for investment. 50% of the existing loan is $50,000. So land component of each is $50,000. Building component of each is $250,000 with Tom borrowing the lot. Total loan for each portion will therefore be $300,000.

Tom borrows $600,000 in one big loan. Keeps his cash in the offset and pays a bit of interest along the way. 50% of the interest should be deductible as half relates to an investment property.

Once finished Tom splits the loan into 2 portions of $300,000 each. he then uses his $250,000 to offset Going forward he pays interest on $50,000 which is not deductible and claims interest on $300,000.

What if Tom did it without seeking advice? He probably would have borrowed $250,000 extra. He would then have had a big loan of $350,000 ($250k plus land) but only be able to claim the interest on $175,000. He would also have a larger non deductible debt of $175,000. If he didn’t know the tax laws he would have kept going with his mixed purpose loan creating a further tax mess.

$300,000 x 5% = $15,000 per year

$157,000 x 5% = $7,500 per year.

Tom has increased his tax deductions by $7,500 per year for the next 30 years or so.

Terry, would this work if you used equity to fund the construction? For example, Tom has $100k PPOR loan, and can draw $250k in equity from another IP. He also has $100k in cash that tree wants to keep. He would then need to borrow a further $250k to cover the construction costs.

At the end of construction, could Tom refinance and combine the three loans (PPOR, equity, and construction) into two loans of $300k each? Cash goes into offset against PPOR.

A bit messier, but all the funds are borrowed. Any deductability issues with this scenario if one is kept as PPOR and one rented?

I’d like an advice for the best tax strategy for the following scenarios involving a duplex too but this one can be split (Parramatta council, 997sqm, R2 zoning)

Situation:

My friends want to give some capital to their son to purchase a house by making a profit on their existing land with an old house on it. They also want to move out and downsize their home.

1. Owners build a duplex and split into two titles. Owner lives in one for 12 months and sell it, and then gives the other to their son to live in.

2. Owners build a duplex live in it for 12 months, split into two titles then sell both.

3. Owners build a duplex and live in it for 12 months before splitting the title, then split it and sell one and give the other to their son to live in.

Rough numbers-

Land value – 900k

Build + other cost – 800k

Sell price of each duplex unit – 900k

What should the owners do that makes the most financial sense?

Any help would be appreciated!

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GST, Income Tax, etc....
An isolated transaction would fall within the thresholds for GST and there is a profit making (profit also means debt extinguishing, equity etc) intent. ABN needed, GST registration, margin scheme ?? No CGT but income tax....Specific issues re apportioning need to be understood too.

Just reviving this. In this scenario, is it possible to split the original loan unevenly? Ie Tom buys the land for $500k, borrows $400k and splits the loan $250k for the investment half and $150k for the PPOR half? This would maximise deductible interest from day 1 but Im assuming its not allowable...?

Just reviving this. In this scenario, is it possible to split the original loan unevenly? Ie Tom buys the land for $500k, borrows $400k and splits the loan $250k for the investment half and $150k for the PPOR half? This would maximise deductible interest from day 1 but Im assuming its not allowable...?

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You could, but would the interest be deductible in full? I think not, unless there is a reasonable basis. The investment portion may have a different aspect and may be worth more for example.

Just reviving this. In this scenario, is it possible to split the original loan unevenly? Ie Tom buys the land for $500k, borrows $400k and splits the loan $250k for the investment half and $150k for the PPOR half? This would maximise deductible interest from day 1 but Im assuming its not allowable...?

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Refinance = No.
Acquisition of two duplex titles (not one) = Yes.

Remember it is the USE of the borrowed money that determines deductibility. So if you had two contracts to build two dwellings you could draw and pay borrowed money in different portions. However if it was a single duplex title, one building contract etc then its not possible to pay distinct amounts for each portion as there is a single asset. Then apportionment would need to be reasonable and to favour a tax deductible portion v's the other poses a concern.

Take care with blending development and a main residence. One can taint the other and loss of the main residence exemption could even occur. eg You decide to sell the investment portion after 12mths. Then later seek to sell the main residence lot. Its arguable that the process was a arrangement intended to produce profit (profit include reduction of debt in the ATO's opiion). TD 92/135 is a tax office view on such concerns. The main residence exemption may not apply if it can be argued the purpose of the developmnet was to produce profit - even a isolated transaction. And you dont have to be a buider.

So how could you structure this scenario to make use of main residence exemption? The intention is to make one half our main residence, although we don't want to be locked into living there for too long...sounds like we need to avoid the eventual sale proceeds being treated as income, but how?

You have to try to make sure it is on capital account. Not leave evidence that the intention is to sell in the short term with a profit. Will you be constructing another property at the same time you are living in this one with the intention of repeating?.

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